Wednesday, May 12, 2004

More lousy economics from Slate

Slate's economics columns have been lousy every since they lost pre-insanity Krugman. But to be honest, almost everything written in mass media on economics is lousy -- making Slate average -- but I hold them to a higher standard because once-upon-a-time they did so well.

Their latest column is on the Evil Evil Bush (who LIES!!!) Evil Evil economics policy (built on LIES!!! and maybe OIL!!! TOO!!!) which, the author assures us, will lead to socialist revolution if it works.

At the heart of the article is Bush plans to reduce taxes on income and savings -- also known as capital. The reason for this, according to Slate, was because

academic economists began to favor a new set of theoretical models where the savings rate took a more prominent role as a determinant of economic growth. In addition, the models suggested that the pace of technological change depended on changes in the size of the capital stock, which can only grow if investors save more

The major ground-breaking work that I know of which links capital investment (what the article refers to as "savings") to long term economic growth is the Solow Growth Model which, unfortunately, demonstrates that a high savings rate is BAD for economic growth. The reason is that large capital investments mean there is all this capital lying around that now needs to be maintained, and the resources that go towards maintaining the capital stock come from the cash that the capital investment throws off. So capital stock ends up eating most of the profits it throws off because, just like a bird with big wings who needs big muscles to move those big wings, but then ends up needing even bigger wings to carry around the extra weight of all those muscles, etc.

An economy that maximizes consumption--ie. one worth a damn--has just the right amount of capital stock, not too much and not too little, and that is the central insight of the Solow growth model. The most observant amongst you will note that this is the exact opposite of what the article claims.

There is a very good reason to not tax savings -- it's very inefficient. Savings can run around easily to avoid tax. Companies can hide profits through depreciation schedules, debt payments, share buy-backs, and a hundred other things taught in first year business school classes. Investors can house money offshore, in various financial instruments, in nonprofit annuity schemes etc. People can simply move savings into things like houses which can be classified as consumption, come with tax breaks, but really are an asset just like anything else. The inefficiency from taxes chasing this money come from 1) the high auditing cost to try and pin this money down and 2) the dead weight loss (economic distortion) that comes from the forgone opportunities that these shenanigans preclude. Countries with high tax loads, like Sweden, have much lower capital tax rates than the US because of these inefficiencies.

It's also important to make a clear distinction between savings and investment -- another critical distinction that the article fails to grasp. Savings is just deferred consumption--instead of spending money now you are just spending money later. People are very bad at it, and in the US the savings rates are very low. Investment, on the other hand, is money set aside to generate new wealth in the future. It is possible to invest too much and reach a state where money, instead of buying consumption goods, is squandered on hare-brained schemes with zero to negative return. This is happening in China, btw, (and Japan, but for very different reasons).

The article finally argues that taxes on savings tend to be progressive, so reducing them exacerbates inequality. It is true that rich people save more and so bear a heavier tax burden on savings, while a tax on consumption falls more heavily on the poor, and this is the main reason why consumption taxes are so unpopular. It takes a higher tax burden than the US has now for people to recognize that tax efficiency is important, which means taxing consumption and labor, not savings and capital. The only thing letting the US get away with its inefficient but "socialist" capital focused tax structure is its efficient and "capitalist" low overall tax burden.